Assessing the impact of Brexit on the economic activity of the UK's closest partners: the trade channel

The European Union is a highly integrated free trade zone in which goods circulate freely, and as such the potential consequences of Brexit are multi-faceted and difficult to predict. While much has been written about the possible effects of Brexit on the British economy, its potential impact on the United Kingdom’s main partners has received less attention. The purpose of this dossier is to estimate the knock-on effects of Brexit on economic activity in these countries, with particular focus on trade.

Brexit could result in an increase in customs duties between theUnited Kingdom and its trading partners, which would have consequences for international trade and thus for world demand for the products of all countries involved. Themethod used here takes into account the international nature of value chains, estimating the distribution of shocks between the UK’s trading partners. This serves to precisely identify the circuits through which the initial shocks from disruption in British trade would be transmitted, both by country and by product, along the whole length of the value chains.

For the purposes of this report we have analysed two potential scenarios for the UK’s exit from the EU. In the soft Brexit scenario, the United Kingdom and the EU would succeed in reachingadeal, triggeringaperiodof transitionwhichwould run until 31st December 2020. Any increase in customs duties would thus be delayed until 1st January 2021. In this case the cumulative effect on French economic activity would be equivalent to –0.3% of GDP, spread over several quarters. In our hard Brexit scenario, the two parties fail to reach a deal: the sudden hike in customs duties following a hard Brexit would cost the French economy 0.6% of GDP, spread over several quarters. Other countries could be hit harder, for example Ireland (between –1.4% and –4.1% of GDP) and Germany (–0.5% to –0.9%). In both cases these are counter-factual projections, i.e. based on attempts to predict what GDP would have been without Brexit, not the actual current level of GDP.

This estimate is based on the assumption that the general structure of world trade remains unchanged. Modelling the decline in trade between the United Kingdom and its trading partners does not take into account the potential reorganisation of international production chains and demand for products, which could offset the negative impact. On the other hand, nor does this method account for other channels through which the shock further to Brexit might spread, such as the effects on capital transfers or the migration and freezing of investment. Moreover, non-tariff barriers could significantly aggravate the estimated effects of Brexit.

Given the high level of uncertainty involved, this exercise does not constitute an alternative to the detailed forecasts for the French economy contained elsewhere in this Conjoncture in France report. A hard Brexit at the end of March 2019 would undoubtedly have a negative impact on the growth forecast forQ2 2019. But the effect for Q2 alone cannot be deduced simply from the estimates contained in this Special Analysis, especially since the British government could take a unilateral decision to delay the application of customs duties on imports from the EU, while also temporarily reducing some of the duties charged on imports from the rest of the world.